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08.06.2017 17:03 Age: 105 days
Category: News

Passive investing’s dark side


Writing in Financial Times, Renaud De Planta, chairman of Pictect Asset Management, warns that passive investing could threaten the free-market economy.

As a reminder, passive investing can be defined as an investment strategy that aims to maximize returns over the long run by keeping the amount of buying and selling to a minimum. The main idea is to avoid the high fees and the ensuing drag on performance that often  occurs from frequent trading. Despite its name, passive index investing is increasingly just like  active investing with a different name says De Planta. Indeed, “passive” investing involves a lot of “active” selection of which stocks to passively invest in.

Passive industry management has become an oligopoly, with 3 large managers “drawing on seemingly limitless economies of scale” and amassing assets “simply by slashing costs”. With few companies selling the same products, passive investing “erodes competitive forces”.

Beside this reduction of potential competition, there is also a concern regarding the  growing influence of these players over capital markets and international capital flows.  They will end up owning large swaths of the capital market and will have the power to decide on the composition of stock and bond indices but also which country or company should be excluded or included from those benchmarks. A recent illustration of this phenomenon is BlackRock’s call to include China in MSCI’s global equity indices.

Another consequence of passive investing is that if passive funds monopolized investment flows, pricing mechanisms in the stock market will break down. In that case, the price of a stock would no longer reflect a company’s actual performance, because their shares would be bought simply as a result of their inclusion in an index.

Finally, De Planta concludes that even though passive investing benefits investors thanks to their low cost, it could threaten the economic system.

For a different take on the passive investing phenomenon, please see Better Finance’s research on Closet Indexing.

Read the full article in the Financial Times here


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